AAII Investor Update: Put an Asterisk by Second-Quarter Results

Thursday, July 26, 2012
Charles Rotblut, CFA
AAII Journal Editor

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Sentiment Survey

This week’s AAII Sentiment Survey results:
  Bullish: 28.1%, up 5.9 points
  Neutral: 28.8%, down 7.3 points
  Bearish: 43.1%, up 1.3 points

Long-term averages:
  Bullish: 39%
  Neutral: 31%
  Bearish: 30%

Take the AAII Sentiment Survey »


If there is a common theme we are seeing in second-quarter earnings reports, it’s the adverse impact the stronger dollar and the weaker global economy are having. Many companies are blaming both for dampening profits.

The slowing economy is curtailing spending. Earlier this week, truck manufacturer Paccar (PCAR) said its customers are choosing to hold onto aging trucks for a longer period of time, rather than replace them. The stronger dollar is hurting companies ranging from PepsiCo (PEP) to United Technologies (UTX). My colleague Wayne Thorp and I both feel like each earnings report we look at has a profit number that has been adjusted to offset the impact of currency translation.

Despite this, second-quarter earnings are coming in better than forecasts. As of this morning, Thomson Reuters I/B/E/S calculates that out of the 260 S&P 500 to report so far, 67% have topped expectations, while just 22% have missed. Historically, 62% of companies beat estimates and 20% miss.

Unfortunately, the second-quarter numbers that topped estimates need a big asterisk by them. Brokerage analysts reduced their earnings forecasts throughout the second quarter and evidently lowered the bar enough. (At the start of April, Thomson Reuters I/B/E/S’ consensus estimate called for 9.2% growth in second-quarter profits; today, the blended forecast of reported numbers and current forecasts calls for just 6.1% growth. S&P Capital IQ’s numbers, which are adjusted and currently signal a decline of 0.65%, have also been revised downward over the past few months.)

Revenues don’t look great when compared to expectations either. Thomson Reuters says only 41% of reported companies topped projections, while 59% reported disappointing sales numbers.

One of things the market does have going for itself is a cheap valuation. The S&P 500 is trading at 13.2 times trailing 12-month (TTM) earnings and 12.3 times I/B/E/S’ projected profits. Using S&P Capital IQ’s numbers instead gives us a trailing price-earnings ratio of 13.3 and a forward price-earnings ratio of 12.7. The earnings yield of 7.4% also favors stocks, especially when compared to the extraordinarily low yield of 1.43% for the 10-year Treasury note.

Could stocks get cheaper? Unfortunately, yes. But by staying out of the market right now, you are also risking the possibility that stock prices will actually rise over the next several months. Catalysts for such an increase would not only include expectations for some type of agreement out of Washington on the budget and taxes, but also actions by the Federal Reserve and the European Central Bank (ECB).

There continues to be expectations that the Federal Open Market Committee will announce a new round of quantitative easing. The timing of the so-called QE3—we’re on a modified version QE2 right now—is unknown, but it could happen before the election. ECB president Mario Draghi proclaimed this morning, “Within our mandate, the ECB is ready to do whatever it takes to preserve the euro.” I won’t speculate on what the ECB will or won’t do, especially since headlines from across the Atlantic continue to feel like they’ve been recycled. I will remind you, however, that alongside all of the fear and skepticism that existed in 2008 and early 2009, there was also a lot of chatter and pronouncements from central banks and government officials. What there wasn’t, however, was a big, flashing billboard telling you that Mr. Market changed his mind and became convinced that the financial system was not going to fall into the abyss.

We never know that a bottom is being set until we’re past it, and false market bottoms have been set before. But, just as there is a risk of further price declines, there is also the risk of missing out on potential gains. As I commonly tell members who ask whether now is a good time to invest or not, we’re in a situation where things could go very wrong, but could also go very right.

More on AAII.com

  • The Portfolio Review: Why It Is Important and How to Do It – If you are nervous about the current markets, one of the things you can do is review your portfolio to catch mistakes and to correct your course on a timely basis. Julie Jason explained what you should and should not consider in this January 2010 AAII Journal article.
  • What You Can Learn From Shareholder Letters – Since we are in the midst of earnings season, I thought it would be useful to highlight this article about what to look for in shareholder communications.
  • Using the Estimate Revisions Up 5% Screen – This screen looks for companies whose earnings estimates have recently been revised up by 5% or more. You can see how other AAII members are using it, and my suggestions for reducing the number of trades, on our discussion boards.
  • Don’t forget to take the Sentiment Survey.

The Week Ahead

More than 100 members of the S&P 500 are scheduled to report earnings next week. Included in this group are Pfizer (PFE) and Kraft Foods (KFT), which will report on Tuesday and Thursday, respectively.

The week’s first economic reports of note will be June personal income and spending, the Conference Board’s July consumer confidence index, the May S&P Case-Shiller home price index and the July Chicago PMI, all of which will be published on Tuesday. Wednesday will feature the July ISM manufacturing index, June construction spending and the July ADP employment report. June factory orders will be published on Thursday. Friday will feature July jobs data—including the change in nonfarm payrolls and the unemployment rate—as well as the July ISM non-manufacturing index.

The Federal Open Market Committee will hold a two-day meeting starting on Tuesday. The meeting statement will be released on Wednesday afternoon.

AAII Sentiment Survey

Bullish sentiment rebounded, but stayed below an unusually low level of 30% for the second consecutive week in the latest AAII Sentiment Survey.

Bullish sentiment, expectations that stock prices will rise over the next six months, rebounded by 5.9 percentage points to 28.1%. Even with the improvement, this is the first time optimism has been below 30% for two consecutive weeks since May 31 and June 7, 2012. This is also the 17th consecutive week that bullish sentiment has been below its historical average of 39%.

Neutral sentiment, expectations that stock prices will stay essentially flat over the next six months, plunged 7.3 percentage points to 28.8%. This is only the second time in the past six weeks that neutral sentiment has been below its historical average of 31%.

Bearish sentiment, expectations that stock prices will fall over the next six months, rose 1.3 percentage points to 43.1%. This is a four-week high for pessimism. It is also the 12th consecutive week and the 15th out of the last 16 weeks that bearish sentiment has been above its historical average of 30%.

AAII members continue to worry that further declines in stock prices could occur over the short term. Bullish sentiment is in the midst of its longest streak of below-average readings since a 29-week period between April 2, 1993, and October 15, 1993. Market volatility, slowing global economic growth, Washington politics and the European sovereign debt crisis are all responsible for the downbeat outlook.

This week’s special question asked AAII members whether slowing global economic growth, the potential U.S. fiscal cliff or the European sovereign debt crisis pose the greatest risk for stock prices. Members were split between the three, though the fiscal cliff-the potential for significant budget cuts and the expiration of tax cuts-received just a few more votes than slowing growth or the European crisis. Several members said all three pose significant risks.

Here is a sampling of the responses:

  • “The U.S. fiscal cliff because all solutions hamper growth. Doing nothing puts us on the brink of disaster.”
  • “The U.S. fiscal cliff. The world needs the U.S. economy to be decent and this could kill it.”
  • “The European sovereign debt crisis. The fall of the euro will lead to a global banking crisis.”
  • “Slowing economic growth is the greatest risk because it will exacerbate both of the other risks.”
  • “Each risk is hard to quantify and if a worse case scenario occurs, it could have a significant impact on stock prices.”

» Take the sentiment survey